Gundlach Unlocked: Positioning for Higher Rates and Persistent Inflation

Welcome everybody to our second episode of Gunlock Unlocked. We did one at the beginning of the year and this is the second one. The reason I've created this podcast is that many times when I would give podcasts on my various mutual funds and ETFs, I'd get questions in the Q&A section about what funds of yours do you recommend that I buy. And I decided that I would have a webcast podcast focused on that idea by going through a macro environment that supports an asset allocation across a number of our mutual funds and ETFs. So let's get started.

This is a chart of the Bloomberg Aggregate Bond Index yield to worst calculation going back to the mid 1990s. And it's interesting that the 10-year average and the 20-year average of the yield of the Bloomberg Aggregate are one basis point different. It's kind of surprising that the 10-year and the 20-year number are within one basis point of each other. And the 30-year average of the Bloomberg aggregate yield is 4.05. Most people would probably have guessed that the 30-year average yield would be higher than 4.05. But you have to remember that we had about 15 years of financial suppression with zero interest rates even though they shouldn't have been at zero ever in my opinion. But they remained at zero for so long that they ended up ushering in the era of money printing, particularly advanced by the COVID lockdown money printing that led to a surge in inflation. So really, where we are now with the yield at 4.78 on the Bloomberg Aggregate is really kind of the same as it was back in 2006, 2007, 2008, which is kind of interesting because I think some of the financial conditions we're experiencing right now also resemble other periods of excess in markets and brilliant attitudes regarding various sectors of the equity market.

We've seen that long-term interest rates in developed countries have been rising since 2019 or 2020 and they've risen rather a lot. The UK rose the most, now at 560, and we saw Australia. The United States is third with a 30-year yield at 5.01, and Switzerland, as is typical, is the lowest yield of developed countries at only 65 basis points. Back in the OOS's, Japan actually was lower for a while there, but this has been a very sharp yield rise. In fact, bonds that were purchased at a 1% yield in the United States back in 2020 fell over 52% in value by the time 2022 rolled around. And those prices have not recovered because, as you can see on the graph, the black line for the United States shows the yield on the 30-year Treasury bond is basically the highest it's been over this entire exhibit's history. So we have seen tremendous losses on long-term Treasury bonds. And I've been warning investors for quite some time now, a couple of years at least, to avoid long-term government bonds in developed countries, including the United States. That remains my point of view. I believe that 30-year rates will not see significant downward movement even if the economy goes into recession and especially if the Fed were to cut interest rates, which is no longer the view of the market. That is a fairly dramatic shift from what many market participants were talking about as recently as January, even as recently as March.

I always say that the Fed follows the two-year Treasury, and we can prove that with this one chart going back to 2004. You can see that the tan line is the federal funds rate and the dark line is the two-year Treasury yield. And it's quite obvious that in 2004, the two-year Treasury started to rise as the Fed funds rate was stable, and it rose rather a lot from a one-handle to about a four-handle, and the Fed was forced, kind of dragging kicking and screaming, to go along with the two-year. The two-year finally peaked out in 2006, 2007, and at that moment it was exactly the same as the Fed funds rate. So the Fed finally, after two or three years, got the Fed funds rate in sync with the two-year Treasury only to be surprised by the two-year, which started to fall once the Fed really reached the same level as the two-year. It started to fall in earnest as weaknesses were starting to show in 2007, 2008. But of course, again, the two-year led the Fed in cutting rates. Then let's just fast forward to around 2015 or so, and we can see that the two-year Treasury yield was rising and it took a couple of years for the Fed to get the message and start raising interest rates. And once again, the two-year Treasury peaked out before the Fed got to its peak rate for that cycle. And then the two-year Treasury rate started to fall rather quickly, and the Fed once again was behind the curve.

Then let's look at 2021, 2022. The two-year knew. Intelligent investors in the bond market knew that the money printing of 2020, 2021 into 2022 was going to cause very elevated inflation. One person that didn't understand that unfortunately was the head of the Federal Reserve, Jerome Powell, who was very late in raising interest rates and once he started, raised them very timidly. That first hike in 2022, I was on CNBC as I've done for multiple years now after the Fed press conference, and I said the Fed should not have raised rates 25 basis points today. They should have raised them 200 basis points today. And everyone gasped when I said that. But lo and behold, we saw that the Fed had to raise interest rates by 200 basis points in the ensuing couple of meetings. So finally the Fed started to get in sync, but the two-year Treasury topped out in 2023 with its rate at the highest level on this chart basically, and the Fed kept rates higher even though the two-year Treasury was collapsing in yield. At the bottom of the chart, you can see the red shaded area, how far below the Fed funds rate the two-year Treasury got to before the Fed finally woke up and started to cut rates and they had to do a jumbo cut to get things started because they were that far behind.

This is a chart by JP Morgan Asset Management. I want to give them credit because this is a very clever chart. I've enhanced it a little bit trying to make it even more informative. What JP Morgan did is they did a scatter plot using manufacturing employment index on the x-axis and the manufacturing prices paid index on the y-axis. And you'll notice that there are kind of red dots and blue dots. The red dots on the scatter chart represent moments that the Fed tightened the Fed funds rate, and the blue dots represent moments when the Fed cut the Fed funds rate. And I've taken the liberty of drawing these red rectangles. And those are to point out an unusual dichotomy of Fed behavior.

Let's start with the upper right-hand red rectangle. We see that there's a lot of red dots in that rectangle, but strangely there are also some blue dots in that rectangle. It's strange that the Fed would be cutting interest rates when you have high manufacturing employment index above 50, meaning tighter labor conditions, and on the y-axis, manufacturing prices paid were very high at that time, above 50 indicates rising input prices, and in that red rectangle everything's basically 75 or higher on the manufacturing prices paid index. So I've taken the liberty of labeling these odd blue dots that are in the red rectangle. I've labeled the ones that are most unusual because they represent particularly high employment indices and particularly high prices paid indices. You'll notice that three of them were in the 1970s: September 1973, July 1974, and July 1976. And these were under the Fed chair stewardship of Arthur Burns, who was intimidated by Richard Nixon to keep interest rates at an easier position than was probably warranted by economic conditions. You'll also notice in the red rectangle there's another one labeled March 2008. I point that out because that was obviously a very unusual situation. That was the collapse of Bear Stearns in March of 2008 which led to an emergency being detected by the Federal Reserve. So in spite of the fact that prices were not looking very good on the ISM index and the prices paid was very high, they cut rates because they sensed there was an economic emergency.

Notice that there is an orange circle that's larger than any of the dots. It's in that upper right red rectangle. That's where we are right now. So one would say that based upon this scatter plot, it would be much more likely and prudent that the Fed hike interest rates here in 2026 or in 2027 rather than cutting interest rates. And so many investors entered this year with their number one bullish pillar being the Fed's going to cut rates at least two times in 2026. Well, at this point, I think there's no chance that they're going to cut rates in 2026. I in fact pointed that out as far back as January when I was doing the Fed day in January. I said I don't think the Fed's going to cut rates at all this year. In fact, if I had to bet, I would bet they would hike them. That was rather an astonishing headline. It went instantly to top go on Bloomberg that I was saying that.

Now let's look at the lower left on this exhibit. And that's unusual too because here you had very weak employment ISM index, the weakest readings on the entire exhibit. And you also had very low prices paid on the ISM. You would typically think that might be a time when you would cut interest rates, but instead in January of '82, September of '82, and August of '85, Paul Volcker, when men were men is what I say, when the Fed actually was doing things that were not just following the two-year, and we'll get to that in a moment, but in spite of a very weak employment index and very weak prices paid index, particularly in September of 1982, Volcker hiked rates and he said, 'I don't care what happens to unemployment or the economy. We've got to get rid of this inflation problem.'

So let's take a look at what Volcker did around these time periods. This exhibit shows the Fed funds rate versus the two-year Treasury yield from June of 1979 to June of 1983. And boy does this look different from the first chart I showed of more recent years comparing the two-year Treasury to the Fed funds rate because it's obvious that Volcker was not paying any attention really to the two-year Treasury. The blue line is the Fed funds rate. You'll notice that Volcker started raising rates in the second or third quarter of 1979 before the two-year Treasury rate started to go up. And you'll notice that he kept rates high at 14% in the fourth quarter of 1979 even though the two-year rate was falling. So he wasn't following the two-year. In fact, the two-year from October of '79 to maybe February of 1980 was basically unchanged. So was the Fed funds rate, but then almost instantaneously the Fed raised rates 600 basis points from 14 to 20%. And you'll notice the two-year Treasury never got above even 15.5. So it's clear that Volcker was not following the two-year. He was 500 basis points higher. But Volcker was very agile. You'll notice that just a couple months later, after he raised it 600 basis points to 20%, he changed his mind and cut it all the way down to 11.5%, blowing way past where the two-year Treasury was. So at the moment that he went from 20 to 11.5, the two-year Treasury was still up at about 14.5%. So he was way out of line by about 300 basis points from the two-year. And then you'll notice that the two-year Treasury started to rise and Volcker took the Fed funds rate in 1980 into 1981 all the way from 9.5% to 20%. And once again, the two-year never got above 15 during that time period. So again, it's clear that Volcker did not follow the two-year.

I'm wondering if Mr. Worsh, who's going to have his first press conference next week, I wonder if he's going to be a little bit more agile than what we've seen from the past three or four Fed chairpeople. I hope he is. There's indications that he's going to eliminate the SEP, which I think is a wonderful idea since it's never been right. That's the guesses of where maybe the economy, unemployment, and the inflation rate might be in upcoming two or three years. They've never been right on that or even close. So why embarrass yourself over and over again and keep doing it. But also, it's possible that the dot plots entirely will be eliminated, and we'll see if that happens. If he does eliminate these traditions that over the past couple of decades, I suspect we might see more Volcker-esque behavior rather than the cynical exercise of simply following the two-year, which has been the name of the game now at least back to 2004 as we saw.

We have a model at DoubleLine that I created, it's got to be about 10 to 15 years ago now, which is non-intuitive. It's a starting point for where we think the 10-year US Treasury yield should be based upon two economic indicators: nominal GDP in the United States, 7-year moving average, and the German 10-year yield. Those might seem like strange bedfellows, but it turned out that I observed in the earlier part of the 2010s that this indicator seemed to be uncannily good at pegging where you might think the 10-year Treasury should be. And you'll notice that it continues to work. Obviously, there are some gaps at various points in time between this model and where the 10-year Treasury yield is. But you'll notice that ever since 2021, this has worked extremely well. And interestingly, it shows that the 10-year Treasury yield is exactly the same as the model predicts using the 7-year moving average of nominal GDP and the German 10-year yield, at 4.53. And it's been that way for the bulk of the last two or three years. So it's not really that surprising that there's been relatively little movement. There's been a range in the 10-year Treasury with little movement. We're near the higher end of the range, but we're still very much in the range that's defined the past three years. So the 10-year Treasury yield sort of makes sense where it is right now unless we see something happen with the economy, meaning either higher nominal GDP, which frankly I think is a possibility given the inflation we'll talk about in a later segment, and the 10-year German yield, which as we saw on the second slide, has been on the rise along with other developed market yields. So the pressure seems to be for higher 10-year Treasury yield at the moment rather than a lower 10-year Treasury yield.

This shows the 30-year Treasury bond yield going back to 1990 for completeness. We've seen the twos, tens, and now the 30s. You'll notice, as I said earlier, the 30-year Treasury yield is basically on its highs of the past 20 years. There was a little bit of a rally back in 2024, 2025, but that's completely reversed and we now sit at basically the high 30-year Treasury yield. These lines on the chart show one and two standard deviations around the trend line at the center of the exhibit. So we used to live within the two standard deviation bands for a 30-year Treasury all the way from 1990 until 2023. And since then, we've broken out above it. And I question whether we will ever go back into this band unless we get some sort of unusual government action like yield curve control, which I would not rule out, or some other extraordinary measures that may come to play because one of the entitlement systems announced this week that they will run out of money by 2032. This is a major entitlement program that funds retirement payments to older people, retirees. And what that means, since they acknowledge now in plain English that they know they'll run out of money by 2032, that means they're going to run out of money before 2032. I would guess more like 2029, which is two and a half years away. So this is going to be a really big issue and it's one of the reasons why for the time being we have avoided long-term treasury bonds and that's been a good move broadly speaking over the past two and a half to three years.

Let's go into measures of the consumer. We're using the University of Michigan consumer sentiment index. There's another one by the Conference Board which isn't quite as weak, although it is on the weak side, but I'm using the University of Michigan because we have granular data that we're going to dive into in the next two or three slides. You'll notice that the University of Michigan consumer sentiment index is at its lowest reading in the last 45 years. So it's been plunging and it shows that consumers do not feel good about their current economic situation.

Now we can delve into this by comparing it to normal conditions. You notice there's two lines on the exhibit. One is the same as the prior slide, the blue line, the consumer sentiment index. Then there's this tan colored line which is a proxy for what consumer sentiment might be expected to be on this survey. The inputs into the consumer sentiment prediction model are financial market things such as personal spending 12 months change, the U3 unemployment rate, the CPI 12-month change, and the 12-month change in the S&P 500. Your eye will readily see that the blue line and the tan line were basically the same line for 40 years from 1980 to 2020, and then all of a sudden they diverged from each other. And now the tan line says that you would have expected from the performance of the S&P 500 and the other indicators that I mentioned that we would have a 95 handle on the consumer sentiment index, which would be a very normal reading. It's lived at 95 for most of the observations on this chart. But instead, we're less than half that with a 44 handle, which shows that something has changed starting in 2020. I would suggest that one of the major things that changed starting in 2020 was interest rates bottomed in 2020. As I said at the time, it will be remembered as the secular bottom in interest rates with short rates at zero and the long bond at 1%, which was just an insanely low level. And I talked about it very vocally at the time. But interest rates have risen, and I began to talk about that with secularly rising interest rates, we can expect many of the economic relationships that prevailed from 1980 to 2020 would no longer hold up because they were informed by nothing but secularly declining interest rates. But now that they're secularly rising, at least at the long end, and for the time being, they're at the highs near the highs on the short end as well, we have different things happening. One of those things is homes are no longer affordable. Mortgage interest rates were in the twos and now they're in the mid-6s. This is one reason, I think, why the blue line is so low.

We can also look at the University of Michigan consumer sentiment index by income groupings. We've broken it into the top one-third and the bottom one-third. And one can understand with the economy the way it is, with inflation the way it is and home prices the way they are and the affordability issues, it's not surprising that the bottom third has its lowest reading of all time. But more surprisingly, the top one-third also has a very low reading. Not as low as it was two or three years ago, but one of the lowest readings of the past 45 years from the top one-third. What this clearly suggests is that all income groups think that the conditions in the economy are inferior to most of the conditions of the past 45 years, which does not lead to a happy society as we see in our polarized environment.

Finally, we can look at the University of Michigan consumer sentiment by political party and this one is really much different than the prior one when all the income groups were unhappy. This one we see that Democrats are extremely unhappy, a 32 handle from Democrats, and we see independents are also unhappy. So independents, I guess, don't like either the Republicans or the Democrats, but they're nearly as unhappy as the Democrats, at a 40 handle. Whereas Republicans are kind of at a normal reading at about an 84 handle, which I think is surprisingly high given that the top third in income bracket from the prior slide is also not happy. But somehow Republicans are feeling better in the consumer sentiment index than independents or Democrats. Also reflective, one of the reasons I think why sentiment readings are falling and so very low on the University of Michigan survey, personal savings rate is very low. People don't want to draw down their savings; they don't do it out of desire, they do it out of need. So once they burn through all of that COVID money, which caused that huge spike obviously in 2020-2021, then they drew it down and then they went back up with some good employment that was happening in 2022, 2023, but now we're at one of the lowest readings on record for the personal savings rate. And it appears to my eye to be falling rather sharply. This would be very bad news if it actually went down to meet a level of say 2005, 2006, because we kind of know what happened when the savings rate got that low. It ended up leading to a financial crisis.

Let's take a look at inflation. I mentioned before that inflation I think will be higher than most people have expected and certainly that's been the case. Here's the PCE inflation. This is the number the Fed likes to talk about. I think historically they've chosen the PCE because it's historically been the lowest inflation rate. That's no longer the case. It's kind of in sync with the other inflation measures. But you'll notice that it's rising rather quickly. The headline PCE was starting to rise gently as we entered 2026 and now it's rising very sharply. Obviously, the price of oil and energy has something to do with that, but commodities broadly are up and we're going to be talking about that a little later in this presentation. We see the headline CPI is the highest reading now in three years and it's at 3.8, a long distance from that dotted red line, which is the Fed's purported target of 2%. It's interesting how for five years on this chart, 2% looked like it was a ceiling on the PCE core and headline. And ever since 2021, you can't even get to 2% as a floor. You can only get sort of close-ish to 2%. So this is rising.

This slide I use just to mock it. This is called the Dallas Fed trimmed mean PCE inflation rate. And you'll notice if you look at the description, the tan line is at 2.55. The trim mean is 2.33 and this annual rate at 2.35 on the various lines on the chart. But what the trim mean is, it's not described on this slide, but it's a very cynical exercise. What they do is they think that the items in the economy that are experiencing very sharp price increases and the ones that are experiencing very sharp price declines might not be reflective of what's really the underlying trend of inflation. So they decide to leave out some of the highest inflation components and they leave out the lowest inflation components. But what's really ridiculous about it and this actually does show it's written at the bottom of the slide, they trim the top 31% of the inflation inputs, but they only drop out the bottom 24% inputs, which seems very obviously designed to make inflation look lower than it really is. You're taking out nearly a third of the highest inputs and you're taking out only a quarter of the lowest inputs. This is obviously designed to engineer a lower look to the inflation rate. Just like in the late 70s and early 80s we took out oil and energy, that's why it became, it used to be just CPI then it became CPI ex energy. And then when food became problematic they said CPI ex food and energy. And then at a moment in around 2020 they said let's also take out shelter. So we got to this ridiculous super core CPI excluding food, shelter, and energy, the three things that everybody has to consume, leaving almost nothing left except discretionary spending. So this trim the mean is an embarrassment to the economic industry and shouldn't be used.

So let's look at a scary chart. We have done this arbitrarily but it's uncanny how well this seems to be tracking. What we've done is taken the inflation rate from 1966 to 1982, that's the red line, and we've lined up the most recent eight years of inflation, 2024 to this year. And you see the shape of the two lines, the red line and the black line, are nearly identical in a way which seems like a bizarre coincidence. And unfortunately, we just recently entered the second burst of inflation in the early 1980s. So I don't know if this means that we're on track for this to happen, but it really is interesting the familiarity of the one line vis-a-vis the other line. So we'll be tracking this every month.

So the Fed has long talked about a 2% trend line for the core CPI as being a goal, and I must say they achieved that goal very well for 15 years from 2006 to 2021. The dotted line is the trajectory at a 2% level and the lighter blue line is the actual core CPI, and they're basically the same line for those 15 years. Very little deviation. And then of course we lost our minds with money printing. One thing I'm glad about the money printing is at least no one will talk about modern monetary theory anymore claiming you can print money without inflation because they've all left the building in shame. But you'll notice that the trajectory of the CPI with the money printing went to a whole new level. So what we've done here is projecting this forward. We're trying to say, do you see that dotted line that goes horizontally? We're saying if we want to get back to a long-term so that we have a 25-year experience of truly 2% inflation, what would the inflation rate need to be for the next five years? Well, that's down in the chart in the table at the bottom. We would need zero inflation obviously since it's a horizontal line to get us to the trend line of the dotted dashed line. We would have to have zero inflation for the next five years. That seems extraordinarily unlikely since we're running at about 4% right now on the CPI. What if we wanted to get back to that dashed trend line in 10 years? We'd have to have 1% inflation on average for 10 years. That's not going to happen. So what about 15 years? Have to be 1.3. 20 years it would have to be 1.5 on average per year. 25 years we're talking out to past 2050, we'd be talking about 1.6 inflation rate on average for those 25 years. I don't think any of these things is likely to happen unless we have a deflationary spiral, which is always possible starting from the debt levels that we're on. But right now we're not flirting with deflation at all. Inflation is going the other way.

So I'm wondering if the Fed is going to retire its 2% target. People have been asking Fed chairpeople for quite a couple of decades now, you know, do you think maybe two? Why is 2% the right rate? Why doesn't two and a half or 3%? Well, I think we borrow that from Australia. I think it's where it all started. Something about a 2% inflation rate being some sort of ideal for whatever reason. But there's no reason why they can't say, well, what's wrong with two and a half percent or 3% inflation? Of course, what's wrong with 3% inflation is after about 20 years, you've really destroyed purchasing power very meaningfully. Three is a lot higher than two when you factor in the compounding over longer term time periods. But I wouldn't be surprised if there was no longer talk of a 2% target. Maybe they don't need to have a target. Maybe they just start acting like Volcker did from 1979 to 1983 and start really being agile with the Fed funds rate. We shall see because we'll be hearing from Mr. Worsh just next week and I'll be on CNBC if time permits doing my usual first reflection on what came out of the press conference this time with Mr. Worsh.

Okay, let's look at inflation maybe going forward. We're looking at the US CPI here and we see that energy, which is the dark line, leads services by about eight months. And so we've lined it up with energy which has obviously surged in the most recent months and we've got services lagging behind it by eight months. What this chart suggests is that we can expect higher services inflation in the coming eight months. In fact, if you look at this chart, a very simplistic analysis would say maybe the services inflation rate will go to five or higher in the next few months. That would obviously not be a good development for the Fed chairperson who's already being challenged on the inflation side. There's another one that we do. This is the ISM prices paid leading CPI services inflation also by eight months and it tells basically the same story as the prior chart. ISM prices paid have been rising now for a year. They've risen fairly sharply from around 55 to around 71. That's a pretty big move. And one might expect based upon correlations that the CPI services will go up as well, also suggesting perhaps a level of around 5% or a little higher.

Here are what I call real prices. This is the import and export price indices. These are my favorite inflation indicators. I use them in almost every webcast because they're really unfettered. They're not seasonally adjusted. They don't have all these quality adjustments or hedonics or whatever they call them. These are just prices. And you'll notice that the export prices year-over-year are now at 8.9% and the import prices are at 4.2. I find this interesting because you would think the tariffs would have affected import prices more than export prices, but perhaps this includes energy that we're exporting that has been on a tear in terms of its price level. But in either case, if we average the two together, we get an inflation rate of about six and a half percent on the export/import price indices, and that's in place right now. So that suggests that these other leading indicators in the previous two slides are somewhat corroborative of where services inflation and overall inflation rate may be headed as we move forward in time.

Here are commodity prices which have been incredibly strong. Commodity prices tend to move in fairly long-lasting patterns. You notice that we had a bull market in commodities that was pretty impressive, over 100% return on the Bloomberg Commodity Index from early 2020 to the second quarter of 2022. And then there was a pullback for a couple of years and then starting in the middle of last year, 2025, commodities started to go on another bull run. And that petered out about a month ago and it's now correcting. It broke below its 50-day moving average, the red line. It's now met the 100-day moving average, the blue line. And I wouldn't be surprised at all if this corrected down towards the 200-day moving average. I think that would be a tremendous buying opportunity, but I believe that commodities serve a role in a portfolio even now that they've corrected down to their 100-day moving average.

Now, let's talk about equities. This is the Shiller P/E ratio, the CAPE ratio, going all the way back to the 1880s. And you'll notice that the CAPE ratio is basically the highest of all time, matching the dot-com experience. And we're also in the midst of a massive IPO wave in speculative areas of AI and SpaceX. SpaceX is really AI too mostly, but they also have other business ventures. IPOs, when you get the largest IPOs in history, that usually goes around the vicinity of a stock market top, and certainly the valuation here is supportive of that. We've got SpaceX coming out, touting a $1.88 trillion valuation, and I heard today that it's something like four times oversubscribed. Some are suggesting that stock market weakness might be due to investors making room in their portfolio to take down the SpaceX IPO and perhaps Anthropic and OpenAI as well. I find it very interesting that these mega-cap private companies decided that now is a good moment to be selling. That is not suggestive that these stocks are cheap. Far from it. It's suggestive of a hype cycle on steroids similar to the year 2000 and also in the lead up to the global financial crisis.

This is US stocks versus the rest of the world. When the black line is going up, the US is outperforming the rest of the world. You'll notice that there was monumental outperformance of the US in the aftermath of the global financial crisis. We went far above anything else since the 1970. In fact, it looks like we're up at about three standard deviations, maybe four standard deviations from the red dashed average. And yet, you'll notice that more recently, the rest of the world has been outperforming. I would bet very heavily that that is going to continue in the years ahead. Here's equity prices versus the rest of the world again. This just shows once again that the US has been underperforming the rest of the world for the past year and a half. And I think we're headed to another leg down on this chart, which means the rest of the world outperforming.

Let's take a look at stock market bubble peaks. This is by BofA Global Investment Strategy. Give them credit for this. What we see here is periods of tremendous concentration in markets. The first one on the exhibit is the Nifty 50 in the early 1970s. That's when I really started following finance when I was about 12 years old. And what we saw is that 40% of the S&P 500 was in 50 stocks. At the time that was perceived to be immense concentration that only 10% of the stocks had 40% of the market cap, and of course once it got to 40, there was an instant reversal and we saw a massive bear market going into 1974. Then we see Japan in the late 80s where the Nikkei index was 44% of the entire Morgan Stanley Global Stock Market Index. Japan was 44% of the entire world stock market. Of course, that was an epic top and it led to 35 years before you got back to that price level and a lot of pain along the way. Then we saw the tech and telecom situation of the late 90s into the early OOS's. Once again, 41% of the stock market was in one sector, tech and telecom. But now look where we are today with AI Big 10. This is only 10 stocks in the S&P 500. So we're not talking about 10% of the stocks in the S&P 500. We're talking about way less than that. And it's 41% of the market. And I don't know if you see what I see here, it's already reversing. So it's later than you think. Doesn't mean it can't retrace back up to 40 or 42 or whatever. But this is a very bad time period to be doubling down on this concentrated type of portfolio. And we'll see that in the asset allocation recommendation.

This is also worrisome. We have the Philadelphia Semiconductor Index monthly returns here where the month of April was the biggest month ever. It's very similar to February 2000 which was literally the top in the stock market, particularly in the NASDAQ, in the aftermath of the dot-com madness. And now we see the AI madness that's going on looks very similar. So these are warning signs.

Here's an interesting chart. It shows office construction, the dark line, going up pretty nicely. Then we hit COVID and everybody realized that work patterns might be changing and there was no increased investment in office construction. But then all of a sudden, ChatGPT came out in 2022 and the red line, data center construction, changed its trajectory rather meaningfully and now they've crossed over. It's quite obvious that there is going to be a surplus, an overhang over construction in these data centers, and that is going to lead to a bust in the hype cycle that has been motoring this move in the stock market which appears to be becoming challenged at the present moment. I just thought this was a very interesting slide in the way that these patterns have completely reversed themselves.

This is kind of curious. This is Bitcoin, another asset that's doing nothing for the past several years, and the software sector ETF. And they tracked each other very closely during the later part of 2024 for basically all of 2025 and then still for the first quarter of 2026. It's kind of strange. It was sort of like the speculation on software was the same as speculation on Bitcoin. And then all of a sudden, in the first part of 2026, later part of 2025, software just gave up the ghost. Bitcoin was already falling, but then software and Bitcoin fell together over that same time period from September into February, March, April of this year. And then, weirdly, software caught a bid and it went all the way back up to where it was in the fourth quarter of last year. That didn't hold at all. That was basically short covering and over-pessimism in the first quarter of 2026. But Bitcoin kept falling. Interestingly, just in the last week or so, software has retraced most, or at least nearly half, of its rally, and Bitcoin and the software ETF are in sync together on the downside. I suspect that the software situation will reappear in the news headlines about private credit problems with over concentration. I'm sure most listeners know that the private credit companies do not accurately report their software exposure. They intentionally underreport it by doing things like if they have a software investment that provides software to healthcare companies, they don't call it software, they call it healthcare. So they're obfuscating, which is always the case when you have private markets. Private markets attract people who like to obfuscate because by being private, people can't really look at what's happening. Two companies, OpenAI and Anthropic, do not show their books to anybody. One of them wanted to get a private placement loan to get some capital and a potentially willing lender said, 'Let me take a look at your numbers.' And they said, 'No, thank you. We're not showing you our numbers.' Which might possibly mean that they are dressing up their numbers in a not fully descriptive way to propel the narrative that would fuel a higher IPO price, as if Wall Street would never do such a thing.

Here's another reason to be a little bit suspicious of the US versus the rest of the world. This is price-to-book ratios. The blue line is the MSCI price-to-book ratio at 5.7 for the United States. And then the tan line, which is the whole world except the United States, has a price-to-book ratio of 2.388, well less than half the price-to-book ratio of the US. And you'll notice that there are times when they are at the same level, that the rest of the world is virtually at the same level as the United States, which means that it's not unthinkable that the US could very substantially underperform non-US stocks in the years ahead. I will be recommending that investors position for such an outcome.

Here's the S&P 500 versus just the MSCI Emerging Markets. It's an even stronger outperformance for the past year and a half by emerging markets versus the S&P 500. So while the US market has done very well thanks to the concentration in AI and other go-go momentum sectors, emerging markets have been outperforming and they're basically at their local high over the last year and a half on relative performance. We're reprising the line from the last chart, which is the red line on this chart, the S&P versus the MSCI Emerging Markets. But you'll notice there's an extraordinarily strong correlation to the trade-weighted dollar, the blue line. They zig and zag almost perfectly together. Since the dollar is falling and I believe will continue to fall on a trade-weighted basis, then we would expect the red line to continue to move down, which means that you have emerging markets outperforming the S&P 500.

Now, let's turn to the debt market just to look at EM debt versus US corporate total returns. And you'll notice that the dollar index is the blue line. It's inverted, so the blue line going up means the dollar is going down. And the tan line is the relative performance of JP Morgan local currency to the Bloomberg US Corporate Total Return index. When the tan line is going up, emerging markets are outperforming. So emerging markets have now been outperforming US corporate total return debt for the better part of four years. So that trend continues to be in place. It's one I've been recommending for most of the last four years, but in particular was my strongest recommendation exactly one year ago.

And then we show BDC growth. The gold colored bars have gone from nothing six years ago to an incredible amount. And I'm not going to go into this in depth, but one of the largest BDCs was marked at 100 on December 31st, 2025. And as of some point during May here in 2026, it was marked at 77. That means either every loan dropped 23 points in the first five months of this year, or half the loans dropped 46 points, or a quarter of the loans dropped 92 points. Neither of those three things is good. And so we'll see how that develops. With that, thank you for listening. I appreciate your interest in DoubleLine. I appreciate those of you that invest for your confidence in DoubleLine. Thank you for your attention and goodbye for now.